We use cookies to customise content for your subscription and for analytics.If you continue to browse Lexology, we will assume that you are happy to receive all our cookies. For further information please read our Cookie Policy.

Derivatives Alert - July 6, 2017

The U.S. District Court in the Southern District of New York recently dismissed a class action lawsuit alleging, among other claims, that a large number of entities and individuals in the market for producing, refining and trading Brent crude oil (together, Defendants) manipulated the prices of Brent crude oil and Brent crude oil futures and other derivatives contracts traded on the New York Mercantile Exchange (NYMEX) and the Intercontinental Exchange (ICE Futures Europe), in violation of Sections 6(c)(1) and 9(a) of the Commodity Exchange Act (CEA), 7 U.S.C. 1-26 (2012 & Supp. I-III), and engaged in anticompetitive behavior, in violation of the Sherman Act, 15 U.S.C. 1-7 (2012). In re N. Sea Brent Crude Oil Futures Litig., No. 13-md-02475 (ALC), 2017 WL 2493135 (S.D.N.Y. June 8, 2017) (Brent Crude Oil).1

The district court based its dismissal on the Supreme Court's decision in Morrison v. Nat'l Australia Bank Ltd., 561 U.S. 247 (2010), which held that U.S. law presumptively does not apply extraterritorially to civil actions,2 and the manner in which the U.S. Court of Appeals for the Second Circuit has applied Morrison to complaints alleging CEA3 and securities law violations.4 Following closely on the heels of another Southern District decision dismissing CEA manipulation claims, Harry v. Total Gas & Power N. Am., Inc., 2017 WL 1134851 (S.D.N.Y. Mar. 27, 2017) (Total Gas),5 the district court's opinion illustrates the efficacy of defendants' efforts to highlight the geographic and economic distance between their alleged misconduct in one market and the plaintiffs' trading activity in another. While Brent Crude Oil involved a foreign market (North Sea oil) and Total Gas did not (domestic natural gas), both decisions homed in on the absence of a sufficient connection between the physical market that the defendants allegedly manipulated and the market in which the plaintiffs traded derivatives.

In Brent Crude Oil, Plaintiffs included a putative class of U.S. individuals and entities that traded Brent futures and derivatives contracts on NYMEX and ICE Futures Europe (the Trader Plaintiffs) and a putative class of the owners of landholding and lease-holding interests in U.S. oil-producing property (the Landowner Plaintiffs) (together, Plaintiffs).6 2017 WL 2493135, at *1. Plaintiffs alleged that Defendants engaged in manipulation of the physical Brent oil market in Europe between 2010 and 2012 by, among other conduct, making spoofing-type offers to move the price of "Dated Brent," the primary benchmark for physical Brent oil; manipulative reporting to Platts, a price-reporting agency; and conducting wash transactions. Id. at *3. Plaintiffs further alleged that Defendants' allegedly manipulative conduct had "ripple" effects throughout the derivatives markets, including on Brent futures and derivatives traded on NYMEX and ICE Futures Europe. Id. Defendants moved to dismiss the complaints on several grounds, including on the basis that Morrison barred Plaintiffs from bringing their CEA claims. Id. The district court's application of Morrison here demonstrates that even claims arising from transactions entered into by plaintiffs in the U.S. futures markets may not be sufficient to overcome an extraterritoriality challenge where defendants' alleged misconduct is committed abroad and the connection between that conduct and plaintiffs' domestic trading is too attenuated.

CEA Claims: Morrison and the Presumption Against Extraterritoriality

In Morrison, the Supreme Court applied the presumption against the extraterritorial application of U.S. law to Section 10(b) of the Securities and Exchange Act of 1934 (and Rule 10b-5 promulgated thereunder).7 In determining whether the presumption applied, the Morrison Court explained that only a "clear indication" of congressional intent to apply the law extraterritorially would suffice to overcome the presumption. The Court considered both the language of Exchange Act Section 10(b) and the language in provisions describing the SEC's jurisdiction and the Exchange Act's purposes, 561 U.S. at 261-266, and concluded that none of these sources contained the requisite "clear indication" that could overcome the presumption, including a general reference to foreign commerce in the Exchange Act's definition of "interstate commerce." Id. at 265.

Having determined that the presumption applied, the Court addressed the plaintiffs' contention that their claims did not require extraterritorial application of Section 10(b). Id. at 266.

The plaintiffs were Australians who had purchased shares in one of the defendants, National Australia Bank. The shares were sold on the Australian Stock Exchange after the bank had acquired a mortgage servicing company in Florida. Id. at 252. The plaintiffs alleged that the defendants engaged in deceptive conduct in Florida by manipulating the mortgage company's financial models and making misleading statements. Id. at 252-253. The Court held that the plaintiffs' allegations required it to determine the "focus of congressional concern," id. at 266-267 (internal quotation marks omitted), and concluded that the plaintiffs' allegations failed to establish a domestic case because "the focus of the Exchange Act [was] not upon the place where the deception originated, but upon purchases and sales of securities in the United States," id. at 266. Courts applying Morrison thus conduct a one or two-step inquiry. First, they determine whether a statute gives a clear indication of extraterritorial application; and second, if the statute does not, they ascertain the "focus of congressional concern" in order to determine whether the plaintiff's claims in fact require extraterritorial application of the law. The Brent Crude Oil decision is one of several cases applying Morrison to the CEA in the Second Circuit8 and other circuits.9 The Brent Crude Oil court relied on the Second Circuit's 2-1 decision in Loginovskaya v. Batratchenko, the first and (to date) only court of appeals decision applying Morrison to a private cause of action under the CEA. The plaintiff in Loginovskaya was a Russian citizen residing in Russia who had entered into investment contracts with the defendants, who allegedly operated a group of firms based in New York that invested in commodity futures among other products.10 The plaintiff claimed that the defendants violated Section 40 of the CEA, 7 U.S.C. 6o (2012), which prohibits fraud by a commodity trading advisor or commodity pool operator. The Second Circuit held that Morrison required dismissal of the plaintiff's claims. Loginovskaya, 764 F.3d at 275. The court concluded that, like the Exchange Act, "the CEA as a whole ... is silent as to extraterritorial reach." Id. at 271.11 Because the presumption against extraterritoriality therefore applied, the court had to decide whether the plaintiff's case ran afoul of it. In determining the "focus of congressional concern [in the CEA]," id. at 272 (internal quotation marks omitted), the Second Circuit reasoned that the relevant provision to examine was the CEA's private cause of action, Section 22, 7 U.S.C. 25 (2012), because a private plaintiff "must satisfy [its] threshold requirement[s]" in order to bring suit, Loginovskaya, 764 F.3d at 272. Section 22, the court explained, allows private claims in only four circumstances, each of which is focused on transactions in the commodities markets. Id. The Second Circuit accordingly held that the CEA's focus, at least for private claims, was the same as the Exchange Act's: "Morrison's domestic transaction test in effect decides the territorial reach of CEA 22." Id.12 Applying that test, the court held that the plaintiff fell short because her investment contracts were negotiated and signed in Russia. Id. at 274.

In relying on Loginovskaya, the district court in Brent Crude Oil faced a wrinkle because Plaintiffs, unlike the Loginovskaya plaintiff, clearly engaged in domestic transactions -- at a minimum their trading of Brent futures on NYMEX13 -- but those transactions were not conducted with Defendants. Rather, the transactions that Plaintiffs alleged formed the basis for the manipulative scheme were physical Brent crude oil transactions in the North Sea, and Defendants claimed it was those transactions that mattered under Morrison and Loginovskaya. The district court thus needed to consider which transactions were relevant for purposes of conducting the Morrison and Loginovskaya analysis. Observing that Loginovskaya focused on the plaintiff's "commodity transaction rather than the conduct that allegedly gives rise to a violation," the district court determined that Plaintiffs had "the better argument" that their transactions were the relevant ones. Brent Crude Oil, 2017 WL 2493135, at *6.

But the district court ultimately found it unnecessary to decide the question, because another Second Circuit decision, Parkcentral Global Hub Ltd. v. Porsche Auto Holdings SE, 763 F.3d 198 (2014) (per curiam), made clear that, while a domestic securities transaction was "`necessary to a properly domestic invocation of 10(b), such a transaction is not alone sufficient ... .'" Brent Crude Oil, 2017 WL 2493135, at *7 (quoting Parkcentral, 763 F.3d at 215 (emphasis in Brent Crude Oil)). Parkcentral involved security-based swap agreements based on the value of Volkswagen (VW) stock. The plaintiffs were hedge funds that executed the agreements in the United States and claimed that Porsche Automobil Holding SE and its executives violated Section 10(b) by making false statements about Porsche's plans with respect to the acquisition of VW stock. The Second Circuit ruled that while the plaintiffs' transactions may have been domestic -- they executed the security-based swap agreements in the United States -- those transactions were too far removed from the defendants' alleged fraudulent conduct, which involved "statements made primarily in Germany with respect to stock in a German company traded only on exchanges in Europe." Parkcentral, 763 F.3d at 216. On these facts, the court of appeals explained, "the application of 10(b) to the defendants would so obviously implicate the incompatibility of U.S. and foreign laws that Congress could not have intended it sub silentio." Id.

Similar to Parkcentral, the Brent Crude Oil court ruled that, while Plaintiffs engaged in domestic transactions, the connection between those transactions and the defendants' conduct -- "allegedly manipulative and misleading reporting to Platts in London about physical Brent crude oil transactions conducted entirely outside of the United States" -- was too attenuated. Brent Crude Oil, 2017 WL 2493135, at *7. The court elaborated that Plaintiffs' Brent futures and derivatives trades were "not priced by reference to the Dated Brent assessment published by Platts (which allegedly was inaccurate by virtue of Defendants' manipulative reporting), but instead to derivations of the ICE Brent Index, which does not incorporate the Dated Brent assessment." Id. The domestic location of Plaintiffs' transactions thus was insufficient to overcome the Morrison presumption.

Together, the Loginovskaya and Brent Crude Oil decisions make clear that Morrison presents a daunting obstacle to private CEA claims (at least with respect to futures transactions) that involve some element of foreign conduct. Loginovskaya indicates that plaintiffs alleging CEA violations based on their foreign transactions -- even when those transactions are with CFTC registrants and involve allegedly fraudulent conduct in the United States -- will face difficult, if not insurmountable, Morrison challenges.14 And Brent Crude Oil portends similar headwinds for plaintiffs who engaged in domestic futures transactions but allege CEA violations arising from different transactions conducted abroad.

It also bears noting that while Brent Crude Oil turned on an application of Morrison, its reasoning was reminiscent of Total Gas, where another district court in the Southern District dismissed CEA manipulation claims on the ground that the plaintiffs failed to plead a sufficient connection between the plaintiffs' futures transactions in one market and the defendants' allegedly manipulative conduct in a different market: the physical market for the commodity underlying the futures contracts. See "Skadden Total Gas Client Alert." Indeed, it is possible that the Brent Crude Oil Plaintiffs' claims could not have survived, even absent Morrison, on the Total Gas ground that the complaints did not plausibly allege that Defendants' allegedly manipulative conduct caused Plaintiffs economic harm or "actual damages."15 Given the close scrutiny courts are applying to CEA manipulation claims based on conduct in one market that is allegedly related or correlated to the market in which plaintiffs were trading, defendants facing private CEA manipulation suits would do well to focus on the asserted nexus between their alleged misconduct and the plaintiffs' trading, in addition to whether the allegations implicate the presumption against extraterritorial application of U.S. law.

CFTC Enforcement Under Morrison

Although Loginovskaya's CEA Section 22 "domestic transaction" test does not pose a problem for the CFTC's enforcement program, Morrison could nevertheless still serve as a promising avenue of defense, at least in cases alleging manipulation or attempted manipulation of the futures markets (see note 11, supra). The Second Circuit did hold, after all, that the CEA "as a whole ... is silent as to extraterritorial reach." Loginov-skaya, 764 F.3d at 271. So, the CFTC must establish in the Second Circuit that the particular provision it is seeking to enforce contains clear language to overcome the presumption; failing that, it must establish that the conduct it is challenging is sufficiently domestic in nature to avoid the conclusion that the CFTC's action is "impermissibly extraterritorial" because "[t]he potential for regulatory and legal overlap and conflict" with foreign regulatory authorities is too great. Parkcentral, 763 F.3d at 216. Given that the key CFTC manipulation provisions do not contain any language, much less clear affirmation, of extraterritorial application, CFTC manipulation cases implicating some foreign conduct will require a careful, fact-bound analysis to determine whether the case is predominantly foreign or domestic.16

Antitrust Claims

The facts that created obstacles for the Brent Crude Oil Plaintiffs' CEA claims presented similar challenges for their antitrust claims. Specifically, the district court ruled that it did not have jurisdiction over Plaintiffs' antitrust claims because Plaintiffs did not have antitrust standing. Brent Crude Oil, 2017 WL 2493135, at *7-11. The first criterion for antitrust standing is sufficiently alleging an antitrust injury, a threshold the court ruled Plaintiffs failed to cross. Id. at *9. The flaws that defeated Plaintiffs' CEA claims were equally fatal to their case for antitrust injury. In particular, the district court concluded that Plaintiffs failed to establish that they were members of the "relevant market[s]" that would have been negatively affected by Defendants' alleged anticompetitive activities: the physical Brent crude oil market in which Defendants traded and the market for any derivative instruments "that directly incorporate[d] Dated Brent as [the] benchmark or pricing element." Id. While the Trader Plaintiffs traded Brent futures on NYMEX that were settled to the price of ICE Brent futures, those contracts were based on the ICE Brent index, which, in turn, did not use the Dated Brent assessment in its pricing. Id. at *10. The court noted that although there were some derivatives on NYMEX and ICE Futures Europe that did incorporate the Dated Brent assessment as a pricing element, Plaintiffs did not allege that they traded any of those products. Id. Similarly, while the Landowner Plaintiff was in the market for West Texas Intermediate (WTI) crude oil, Brent crude oil prices were not a benchmark for WTI, and the district court ruled that allegations of a correlation between WTI and Brent prices were insufficient to establish that the Landowner Plaintiff participated in the market allegedly harmed by defendants' anticompetitive conduct. Id. The district court accordingly dismissed Plaintiffs' complaints.17

Conclusion

Although the Morrison test provides a clear avenue for relief for defendants in cases where a plaintiff's transactions are foreign, the decision in Brent Crude Oil demonstrates that courts also will look past a plaintiff's domestic transactions to ensure that a claim does not pose the extraterritoriality concerns addressed in Morrison, especially where the connection between the plaintiff's domestic transactions and the defendant's foreign alleged misconduct is not readily apparent.

This memorandum is provided by Skadden, Arps, Slate, Meagher & Flom LLP and its affiliates for educational and informational purposes only and is not intended and should not be construed as legal advice. This memorandum is considered advertising under applicable state laws.

To view all formatting for this article (eg, tables, footnotes), please access the original here.

Compare jurisdictions:Arbitration

“I find the newsfeeds to be extremely helpful and relevant to my practice area and to the issues facing my company. As I am extremely happy with the newsfeed (it is one of the best I receive) I have no suggestions at this time for improvement.”